You can buy a legal franchise like McDonalds or you can have a business with a natural franchise. Like a local newspaper or maybe the “best” steakhouse in town.
A good natural franchise has a particular advantage. People who want to use the generic service, like print advertising, must pay the appropriate price. Economists call it “rent.” The ability to extract the rent is a serious business advantage.
Some are quite obvious. Dairy Queen. Duracell, See’s Candies, Burlington Northern Sante Fe railroad, and Pampered Chef. Not to mention Geico.
It is three-fold.
Again it is multi-dimensional
Ultimately that’s what drives business value. You can assess your own business in the same way.
Buffett and Munger work at widening the moat. Do what makes your business harder to compete with. They talk about making it wider and deeper and if that is not enough, put some alligators in it. More cash flow.
More free cash flow allows reinvestment in the business. Open another store, buy a competitor, buy a machine that is more efficient than the one you have, pay down expensive debt, do research. Free cash flow is the one metric that establishes clear value. Income is a shadow of it and managing income is not a guarantee of success.
Suppose you made a million dollars pretax. You give the government $250,000 of it for taxes and spend another $1.5 million to stay competitive in your industry. Free cash flow is negative. Did you really make a profit?
Amazon has no income but enormous free cash flow.
Think about your business purpose. Income and cash are not the same thing. Notice how to manage the distinction when organizing your retirement plan
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.
In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772